Global Financial Stability Report

A Report by the Monetary and Capital Markets Department on Market Developments and Issues

Last Updated Wednesday October 05 2016

The Global Financial Stability Report provides an assessment of the global financial system and markets, and addresses emerging market financing in a global context. It focuses on current market conditions, highlighting systemic issues that could pose a risk to financial stability and sustained market access by emerging market borrowers. The Report draws out the financial ramifications of economic imbalances highlighted by the IMF's World Economic Outlook. It contains, as special features, analytical chapters or essays on structural or systemic issues relevant to international financial stability.

October 2016: The current report finds that short-term risks to global financial stability have abated since April 2016, but that medium-term risks continue to build. Financial institutions in advanced economies face a number of cyclical and structural challenges and need to adapt to low growth and low interest rates, as well as to an evolving market and regulatory environment. Weak profitability could erode banks’ buffers over time and undermine their ability to support growth. A cyclical recovery will not resolve the problem of low profitability. More deep-rooted reforms and systemic management are needed, especially for European banks. The solvency of many life insurance companies and pension funds is threatened by a prolonged period of low interest rates. Corporate leverage in emerging market economies remains elevated in some countries, but the current favorable external environment presents an opportunity for overly indebted firms to restructure their balance sheets. The political climate is unsettled in many countries. A lack of income growth and a rise in inequality have opened the door for populist, inward-looking policies. These factors make it even harder to tackle legacy problems and further expose economies and markets to shocks. A potent and more balanced policy mix is needed to deliver a stronger path for growth and financial stability, and avoid slipping into a state of financial and economic stagnation. The report also examines how the rise of nonbank financing has altered the impact of monetary policy and finds that fears of a decline in the effectiveness of monetary policy are unfounded. It appears that the transmission of monetary policy is, if anything, stronger in economies with larger nonbank financial sectors. Finally, the report examines the link between corporate governance, investor protection, and financial stability in emerging market economies. It finds that the improvements over the past two decades have helped bolster the resilience of their financial systems. These benefits strengthen the case for further reform.

April 2016: The current report finds that global financial stability risks have risen since October 2015. The report finds that the outlook has deteriorated in advanced economies because of heightened uncertainty and setbacks to growth and confidence, while declines in oil and commodity prices and slower growth have kept risks elevated in emerging markets. These developments have tightened financial conditions, reduced risk appetite, raised credit risks, and stymied balance sheet repair. A broad-based policy response is needed to secure financial stability. Advanced economies must deal with crisis legacy issues, emerging markets need to bolster their resilience to global headwinds, and the resilience of market liquidity should be enhanced. The report also examines financial spillovers from emerging market economies and finds that they have risen substantially. This implies that when assessing macrofinancial conditions, policymakers may need to increasingly take into account economic developments in emerging market economies. Finally, the report assesses changes in the systemic importance of insurers, finding that across advanced economies the contribution of life insurers to systemic risk has increased in recent years. The results suggest that supervisors and regulators should take a more macroprudential approach to the sector.

October 2015: Financial stability has improved in advanced economies since April, but risks continue to rotate toward emerging markets. The global financial outlook is clouded by a triad of policy challenges: emerging market vulnerabilities, legacy issues from the crisis in advanced economies, and weak systemic market liquidity. Although many emerging market economies have enhanced their policy frameworks and resilience to external shocks, several key economies face substantial domestic imbalances and lower growth. Recent market developments such as slumping commodity prices, China’s bursting equity bubble and pressure on exchange rates underscore these challenges. The prospect of the U.S. Federal Reserve gradually raising interest rates points to an unprecedented adjustment in the global financial system as financial conditions and risk premiums “normalize” from historically low levels alongside rising policy rates and a modest cyclical recovery. Chapter 2 examines in detail the factors that influence levels of liquidity in securities markets, as well as the implications of low liquidity. Currently, market liquidity is being supported by benign cyclical conditions. Although it is too early to assess the impact of recent regulatory changes on market liquidity, changes in market structure, such as larger holdings of corporate bonds by mutual funds, appear to have increased the fragility of liquidity. Chapter 3 studies the growing level of corporate debt in emerging markets, which quadrupled between 2003 and 2014. The report finds that global drivers have played an increasing role in leverage growth, issuance, and spreads. Moreover, higher leverage has been associated with, on average, rising foreign currency exposures. It also finds that despite weaker balance sheets, firms have managed to issue bonds at better terms as a result of favorable financial conditions

April 2015: Global financial stability risks have risen since October. Chapter 1 finds that these risks have also been pivoting away from banks to shadow banks, from solvency to market liquidity risks, and from advanced economies to emerging markets. In advanced economies, the key challenge is to enhance the traction of accommodative monetary policies, ensure a smooth normalization of monetary policy in the United States, and manage the undesirable side effects of low interest rates. Emerging markets must address their own domestic financial vulnerabilities from weaker growth, lower commodity prices, and a stronger dollar, while strengthening their resilience to the changing global environment. Chapters 2 and 3 examine developments in international banking and the potential risks stemming from the financial management industry. Analyzing developments since the global financial crisis, Chapter 2 highlights a shift from direct cross-border lending to local lending by foreign banks’ affiliates. The decline in cross-border lending can be explained by a combination of regulatory changes, weaknesses in bank balance sheets, and macroeconomic factors. This change can positively affect the financial stability of host countries. Cross-border lending tends to compound adverse domestic and global shocks; in contrast, foreign-owned subsidiaries behave less procyclically than domestic banks during domestic crises. Chapter 3 shifts the focus to the asset management industry, particularly “plain-vanilla” products, such as mutual funds. Even these vehicles may pose financial stability risks due to incentive problems between portfolio managers and end investors (which may lead to herding) and due to run risk stemming from liquidity mismatches. The empirical analysis finds evidence for many of these risk-creating mechanisms, although their importance varies across markets. Oversight of the industry should be strengthened.

October 2014: The October 2014 Global Financial Stability Report (GFSR) finds that six years after the start of the crisis, the global economic recovery continues to rely heavily on accommodative monetary policies in advanced economies. Monetary accommodation remains critical in supporting the economy by encouraging economic risk taking in the form of increased real spending by households and greater willingness to invest and hire by businesses. However, prolonged monetary ease may also encourage excessive financial risk taking. Chapter 1 concludes that although economic benefits of monetary ease are becoming more evident in some economies, market and liquidity risks have increased to levels that could compromise financial stability if left unaddressed. The best way to safeguard financial stability and improve the balance between economic and financial risk taking is to put in place policies that enhance the transmission of monetary policy to the real economy—thus promoting economic risk taking—and address financial excesses through well-designed macroprudential measures. Chapter 2 examines the growth of shadow banking around the globe, assessing risks and discussing regulatory responses. Although shadow banking takes vastly different forms within and across countries, some of its key drivers tend to be common to all: search for yield, regulatory circumvention, and demand by institutional investors. The contribution of shadow banks to systemic risks in the financial system is much larger in the United States than in Europe. The chapter calls for a more encompassing (macroprudential) approach to regulation and for enhanced data provision. Chapter 3 discusses how conflicts of interest between bank managers, shareholders, and debt holders can lead to excessive bank risk taking from society’s point of view. It finds that banks with boards of directors independent from management take less risk. There is no clear relation between bank risk and the level of executive compensation, but a better alignment of bankers’ pay with long-term outcomes is associated with less risk.

April 2014: The April 2014 Global Financial Stability Report (GFSR) assesses the challenging transitions that the global financial system is currently undergoing on the path to greater stability. Chapter 1 finds that these transitions are far from complete, and stability conditions are far from normal. For advanced and emerging market economies alike, a successful shift from liquidity-driven to growth-driven markets requires a number of elements. The report discusses these elements, including: a normalization of U.S. monetary policy that avoids financial stability risks; financial rebalancing in emerging market economies amid tighter external financial conditions and higher corporate debt levels; further progress in the euro area’s transition from fragmentation to robust integration; and the successful implementation of Abenomics in Japan to deliver sustained growth and stable inflation. Chapter 2 examines the role of the composition of the investor base and local financial systems for the stability of emerging market portfolio flows and asset prices. Chapter 3 looks at the issue of too-important-to-fail and provides new estimates of the implicit funding subsidy received by systemically important banks.

October 2013: The October 2013 Global Financial Stability (GFSR) Report examines current risks facing the global financial system as it undergoes a series of transitions along the path toward greater financial stability. The United States may soon move to less accommodative monetary policies and higher long-term interest rates as its recovery gains ground. Emerging markets face a transition to more volatile external conditions and higher risk premiums. Japan is moving toward the new “Abenomics” policy regime, and the euro area is moving toward a more robust and safer financial sector. Finally, the global banking system is phasing in stronger regulatory standards. Chapter 1 examines the challenges and risks of each of these transitions. Chapter 2 looks at efforts by policymakers to revive weak credit growth, which has been seen by many as a primary reason behind the slow economic recovery. The chapter argues that policies are most effective if they target the constraints that underlie the weakness in credit. But it cautions policymakers to be aware of the fiscal costs and implications for financial stability of credit-supporting policies. Chapter 3 examines how banking funding structures matter for financial stability and the potential impact of various regulatory reforms. It concludes that careful implementation of reform efforts are important to ensure that financial stability benefits are realized.

April 2013: The April 2013 Global Financial Stability Report examines current risks facing the global financial system and policy actions that may mitigate these. The April 2013 report analyzes the key challenges facing financial and nonfinancial firms as they continue to repair their balance sheets and unwind public and private debt overhangs. Chapter 1 also examines short- and medium-term stability risks in the euro area and the vulnerability of emerging market economies to persistent capital inflows. Chapter 2 takes a closer look at whether sovereign credit default swaps markets are good indicators of sovereign credit risk. Chapter 3 reports on unconventional monetary policy in some depth, including the policies pursued by the Federal Reserve, the Bank of England, the Bank of Japan, the European Central Bank, and the U.S. Federal Reserve.

October 2012: The October 2012 Global Financial Stability Report (GFSR) finds increased risks to the global financial system, with the euro area crisis the principal source of concern. The report urges policymakers to act now to restore confidence, reverse capital flight, and reintegrate the euro zone. In both Japan and the United States, steps are needed toward medium-term fiscal adjustment. Emerging market economies have successfully navigated global shocks thus far, but need to guard against future shocks while managing a slowdown in growth. This GFSR also examines whether regulatory reforms are moving the financial system in the right direction, and finds that progress has been limited, partly because many reforms are in the early stages of implementation and partly because crisis intervention methods are still in use in a number of economies, delaying the movement of the financial system onto a safer path. The final chapter assesses whether certain aspects of financial structure enhance economic outcomes. Indeed, some structural features are associated with better outcomes. In particular, financial buffers made up of high-quality capital and truly liquid assets tend to be associated with better economic performance.

April 2012: The April 2012 Global Financial Stability Report assesses changes in risks to financial stability over the past six months, focusing on sovereign vulnerabilities, risks stemming from private sector deleveraging, and assessing the continued resilience of emerging markets. The report probes the implications of recent reforms in the financial system for market perception of safe assets, and investigates the growing public and private costs of increased longevity risk from aging populations.

September 2011: The September 2011 issue of the Global Financial Stability Report cautions that the risks to global financial stability have increased substantially in recent months, during which heavy public debt burdens and weak growth prospects in many advanced economies combined with a series of shocks to the global financial system. Emerging markets, despite brighter growth prospects, face the risk of sharp reversals and so must guard against the buildup of financial vulnerabilities. Moreover, says the Report, as the crisis has moved into its fifth year, it has entered a new phase in which political differences within and across economies are impeding progress to address the legacies of the crisis. The Report examines how the ongoing low interest rate environment and high uncertainty are driving the asset allocations of long-term, real-money institutional investors, and finds that such investors have moved toward safety and liquidity. As part of its continuing role to find ways of avoiding future crisis, the Report looks at variables that can act as advance indicators of financial crisis and examines how the use of countercyclical capital buffers can help to dampen destabilizing cycles.

April 2011: Despite ongoing economic recovery and improvements in global financial stability, structural weaknesses and vulnerabilities remain in some important financial systems. The April 2011 Global Financial Stability Report highlights how risks have changed over the past six months, traces the sources and channels of financial distress with an emphasis on sovereign risk, notes the pressures arising from capital inflows in emerging economies, and discusses policy proposals under consideration to mend the global financial system.

October 2010: The global financial system is still in a period of significant uncertainty and remains the Achilles' heel of the economic recovery. Although the ongoing recovery is expected to result in a gradual strengthening of balance sheets, progress toward financial stability has experienced a setback since the April 2010 GFSR. The current report highlights how risks have changed over the last six months, traces the sources and channels of financial distress with an emphasis on sovereign risk, and provides a discussion of policy proposals under consideration to mend the global financial system.

April 2010: Risks to global financial stability have eased as the economic recovery has gained steam. But policies are needed to reduce sovereign vulnerabilities, ensure a smooth deleveraging process, and complete the regulatory agenda. The report examines systemic risk and the redesign of financial regulation; the role of central counterparties in making over-the-counter derivatives safer; and the effects of the expansion of global liquidity on receiving economies.

October 2009: This GFSR chronicles the evolution of the path toward reestablishing sound credit intermediation and the near-term risks that could interrupt its restoration, including the rising burden of sovereign financing. The report addresses how to restart securitization markets and the pitfalls if done improperly. The effectiveness of unconventional public sector interventions and the principles for disengagement are discussed. The report also discusses the design of medium-term policies that aim to reshape the financial system to make it more resilient and stable.

April 2009: The global financial system remains under severe stress as the crisis broadens to include households, corporations, and the banking sectors in both advanced and emerging market countries. In normal times, the Global Financial Stability Report aims to prevent crises by highlighting policies that may mitigate systemic risks, thereby contributing to financial stability and sustained economic growth. In the current crisis, the report traces the sources and channels of financial distress and provides policy advice on mitigating its effects on economic activity, stemming contagion, and mending the global financial system.

October 2008: With financial markets worldwide facing growing turmoil, internationally coherent and decisive policy measures will be required to restore confidence in the global financial system. The process of restoring an orderly system will be challenging, as a significant deleveraging is both necessary and inevitable. It is against this challenging and still evolving backdrop that the October 2008 Global Financial Stability Report frames recent events to suggest potential policy measures that could help address the current circumstances.

April 2008: The events of the past six months have demonstrated the fragility of the global financial system and raised fundamental questions about the effectiveness of the response by private and public sector institutions. The report assesses the vulnerabilities that the system is facing and offers tentative conclusions and policy lessons. The report reflects information available up to March 21, 2008.

September 2007: Since the April 2007 Global Financial Stability Report (GFSR), global financial stability has endured an important test. Credit and market risks have risen and markets have become more volatile. Markets are recognizing the extent to which credit discipline has deteriorated in recent years — most notably in the U.S. nonprime mortgage and leveraged loan markets, but also in other related credit markets.

April 2007: This particular issue draws, in part, on a series of discussions with commercial and investment banks, securities firms, asset management companies, hedge funds, insurance companies, pension funds, stock and futures exchanges, credit rating agencies, and academic researchers, as well as regulatory and other public authorities in major financial centers and countries. Contributions from Craig Martin and Kevin Roth (Association for Financial Professionals) in the conducting of a survey are gratefully acknowledged. The report reflects information available up to February 6, 2007.

September 2006: This particular issue draws, in part, on a series of discussions with commercial and investment banks, securities firms, asset management companies, hedge funds, insurance companies, pension funds, stock and futures exchanges, credit rating agencies, and academic researchers, as well as regulatory and other public authorities in major financial centers and countries. The report reflects information available up to July 14, 2006.

April 2006: This particular issue draws, in part, on a series of informal discussions with commercial and investment banks, securities firms, asset management companies, hedge funds, insurance companies, pension funds, stock and futures exchanges, and credit rating agencies, as well as regulatory authorities and academic researchers in many major financial centers and countries. The report reflects information available up to February 10, 2006

September 2005: This particular issue draws, in part, on a series of informal discussions with commercial and investment banks, securities firms, asset management companies, hedge funds, insurance companies, pension funds, stock and futures exchanges, and credit rating agencies, as well as regulatory authorities and academic researchers in many financial centers and countries. The report reflects information available up to July 22, 2005.

April 2005: This particular issue draws, in part, on a series of informal discussions with commercial and investment banks, securities firms, asset management companies, hedge funds, insurance companies, pension funds, stock and futures exchanges, and credit rating agencies, as well as regulatory authorities and academic researchers in many financial centers and countries. The report reflects information available up to February 16, 2005.

September 2004: This issue draws, in part, on a series of informal discussions with commercial and investment banks, securities firms, asset management companies, hedge funds, insurance companies, pension funds, stock and futures exchanges, and credit rating agencies in Canada, Colombia, France, Germany, Hong Kong SAR, Italy, Japan, Mexico, the Netherlands, Poland, Singapore, Switzerland, the United Kingdom, and the United States. The report reflects information available up to July 30, 2004

April 2004: This issue draws, in part, on a series of informal discussions with commercial and investment banks, securities firms, asset management companies, insurance companies, pension funds, stock and futures exchanges, and credit rating agencies in Brazil, Chile, China, Colombia, France, Germany, Hong Kong SAR, Hungary, Japan, Korea, Mexico, Poland, Russia, Singapore, South Africa, Thailand, the United Kingdom, and the United States. The report reflects mostly information available up to March 8, 2004

September 2003: This issue draws, in part, on a series of informal discussions with commercial and investment banks, securities firms, asset management companies, insurance companies, pension funds, stock and futures exchanges, and credit rating agencies in Brazil, Chile, China, Hong Kong SAR, Hungary, Poland, Russia, Singapore, South Africa, and Thailand, as well as the major financial centers. The report reflects mostly information available up to August 4.

March 2003: This issue of the Global Financial Stability Report marks the beginning of a new semiannual frequency for the publication. This issue draws, in part, on a series of informal discussions with commercial and investment banks, securities firms, asset management companies, insurance companies, pension funds, stock and futures exchanges, and credit rating agencies in Brazil, Chile, China, Hong Kong SAR, Hungary, Japan, Poland, Russia, Singapore, Thailand, the United Kingdom, and the United States. The report reflects mostly information available up to February 28, 2003.

December 2002: This is the fourth issue of the Global Financial Stability Report, a quarterly publication launched in March 2002 to provide a regular assessment of global financial markets and to identify potential systemic weaknesses that could lead to crises. This report reflects mostly information available up to November 4, 2002.

June 2002: This is the second issue of the Global Financial Stability Report. This particular issue draws, in part, on a series of informal discussions with commerical investment banks, securities firms, asset management companies, insurance companies, pension funds, stock and futures exchanges, and credit rating agencies in China, Germany, Hong Kong SAR, Hungary, Italy, Japan, Poland, Singapore, Switzerland, Thailand, the United Kingdom, and the United States. The report reflects mostly information available up to May 10, 2002.

September 2002: This is the third issue of the Global Financial Stability Report, a quarterly publication launched in March 2002 to provide a regular assessment of global financial markets and to identify potential systemic weaknesses that could lead to crises. By calling attention to potential fault lines in the global financial system, the report seeks to play a role in preventing crises before they erupt, thereby contributing to global financial stability and to the prospertity of the IMF's member countries.

March 2002: Reviews recent developments in global financial markets and explores the potential market impact of financial imbalances and continued credit quality deterioration. It also focuses on the expansion of credit risk transfer mechanisms -- such as credit derivatives and collateralized debt obligations -- as a means for distributing credit risks. The report concludes with two essays: one on Early Warning System models and another on alternative funding instruments for emerging market countries.